>HINDUSTAN PETROLEUM CORPORATION LIMITED (MERRILL LYNCH)

■ PO implies 19% potential downside; cut to Underperform
HPCL’s share price is up 40% since the election results on 16 May on hopes that auto fuel pricing may be freed up. Even as investors turn bullish, the FY10E earnings outlook has deteriorated, in our view. Auto fuel marketing margins were at supernormal levels until March 2009, but have collapsed and turned negative. Even if auto fuel prices are freed up, only a normal auto fuel margin is likely in FY10E. In this scenario, we only expect a healthy FY10E EPS if oil bonds are issued. HPCL’s new PO of Rs291.4, based on base-case FY10E EPS, implies 19% potential downside. Thus we downgrade HPCL from Buy to Underperform.

■ Cut FY10E EPS 20% on drop in auto fuel marketing margins
We already assumed weak refining margins and significant LPG and kerosene subsidies in FY10E. We were earlier assuming a supernormal auto fuel margin of Rs2/l (US$7/bbl) in FY10E. Auto fuel margins have collapsed since March 2009 and are now negative. Margins to date in 1Q FY10 are Rs0.7/l. Assuming auto fuel pricing is freed up, FY10E margins would be Rs1.1/l. A lower auto fuel margin would have meant EPS of just Rs1.3. Assuming Rs13.6bn of oil bonds limits our FY10E EPS cut to 20% to Rs29.

■ Base- and worst-case PO implies 19-81% potential downside
We calculate HPCL’s PO on three FY10E EPS scenarios. PO based on base and worst-case EPS implies 19-81% potential downside. PO based on best-case EPS implies 18% potential upside. However, the best-case EPS, which assumes a supernormal auto fuel margin of Rs2/l and Brent at US$50/bbl, is improbable, in our view.

■ HPCL to be in red in FY09E
In 9M FY09, HPCL booked a pretax loss of Rs133/share. Although we expect a.4Q pretax profit of Rs114/share, this still means red for HPCL in FY09E.

To see full report: HPCL